Wednesday, February 19, 2014

[dwaterson] Bitcoin – it’s all about the money, money, money

Bitcoin is a new online digital currency which has been in the news recently because of its dramatic price fluctuations. The currency uses peer-to-peer networking for transfers, whereas digital certificates, cryptographics, and decentralised processing provide security. It has been referred to as MOIP – Money Over Internet Protocol.

Bitcoin is a global currency – anyone in the world can open a Bitcoin account, and accept payment for goods and services, or donations, into the account. Bitcoins can also be purchased in the local currency through an exchange. Bitcoins can be transferred directly to anyone who has an account (a Bitcoin address). Transaction costs are low and Bitcoin transactions are irreversible.

Mt Gox is the largest Bitcoin exchange. Bitcoin market prices in the second half of 2012 fluctuated between $6-$12 USD. Prices peaked at $266 on April 10, 2013, and have been hovering above $100 per Bitcoin since then.

The early adopters of Bitcoins were WordPress, Wikileaks, Reddit, and some non-profit organisations who accept donations. The currency is slowly gaining traction amongst companies and BitPay have so far registered about 7,500 retailers. BitPay makes it easier for retailers to accept Bitcoin as payment for goods and services, and to convert Bitcoins into the local currency.

By limiting the supply to 21 million Bitcoins, it is hoped that scarcity will be maintained, which is essential for the value of the currency. If demand grows from more and more people wanting Bitcoins, a limited supply will push the price up. So far, about 10 million Bitcoins have been released into circulation. A mechanism called mining is used to add new Bitcoins into the system at a rate of about 300 per hour. Portions of Bitcoins can be used in transactions, such as a hundredth, thousandth, or millionth, of a Bitcoin.

Credit systems such as Mastercard and Visa required centralised data processing to ensure correct flows and tracking of funds. Bitcoin’s processing consists of adding new transactions to the overall ledger and keeping track of balances in every account. This processing is decentralised in a distributed computing project – anyone can add their computer to the network to assist with the processing and will get paid in newly-issued Bitcoins, through a process called mining. It is this decentralised processing which provides the currency with protection from interference and resilience. Effective Bitcoin mining rigs are now very expensive however.

The Bitcoin currency is global and not controlled by any government or central body. The distributed computing code which checks the ledger after transactions is open source.

Anonymity is possible using the Bitcoin. For this reason it is the currency of choice in the dark web Silk Road marketplace accessible through the Tor network, where drugs are traded. This has attracted bad press for the currency.

Individual security comes from a public/private key infrastructure. Each account (or address) is identified by the public key. Payments made to an account are sent it to the address which is the public key. The private key associated with that address is used to make payments from the account. Individuals using the currency need to employ their own security measures to protect their private key. If the private key is lost, the Bitcoins at the address cannot be accessed. If the private key is stolen, someone else can access the Bitcoins. Users are encouraged to keep two accounts – one for everyday purchases where the private key is stored in a Wallet on their mobile phone, and the other (like a savings account) where larger amounts are stored and the private key is stored encrypted in a safe place. Backup copies should also be kept separately, in different locations and on different mediums.

Will Bitcoin make the world dance? Will it progress beyond a small group of drug dealers, libertarians, and computer geeks? Only time will tell. The concept is certainly interesting and fulfils certain needs. If its usage increases, the price will increase due to limited supply. Investors will be sure to keep an eye on it from this perspective, but Bitcoins are risky – you should not put more in than what you are prepared to lose. Some believe that Bitcoin could make Mastercard and Visa obsolete. If successful, Bitcoin certainly has the potential to have a disruptive effect on local currencies.